How Much Is That Burrito Worth?

A closer look at the Chipotle craze.

A group of University of Florida students once asked Warren Buffett what made a company's moat truly strong. "Forget about share of market," Buffett replied. "I'm talking about share of mind." Judging by opening-day lines that can literally stretch a good two blocks out the door, I'd say that Chipotle Mexican Grill (NYSE:CMG)(NYSE:CMG-B) fits that mold quite well.

I'll admit my own membership in the Chipotle cult. I once frequented the burrito joint so often that the manager gave me free food for three days straight. No kidding.

I don't know anyone who considers this company's future growth potential anything short of spectacular. People go crazy for the opportunity to dine on what Chipotle calls "fast-casual" -- a step above Taco Bell, but a notch below anything that requires a waiter. It's hard not to love the simple menu, the quality ingredients, the food assembly line that Henry Ford would envy, or the feeling that you're about to wolf down a burrito that your stomach is in no way prepared for.

While I agree that the company is phenomenal, I'm less certain about Chipotle stock. Is it worth the price? After months of analyst upgrades and media hype, I'm going to be the black sheep here. At a current valuation of $125 per share, you're better off waiting for a cheaper price. Investors who get too caught up in the flurry and excitement surrounding the company, but fail to pay any attention to the price of the stock, can get seared faster than barbacoa on a Chipotle grill.

I didn't see that on the menuAt nearly 100 times last year's earnings, Chipotle has the highest of expectations already baked into the stock price. Will earnings grow? Absolutely. Will stores expand? Unquestionably. Will it be reflected in the stock price? At these levels, that's not such a sure thing.

As Chipotle employees' T-shirts proclaim, "Good is in the details." Let's take a closer look at those details.

In 2006, Chipotle racked up $41 million in net income, up 10% from 2005. Through June 30 of this year, net income totaled $32 million. Assuming that the company continues this trend, it'll end up with roughly $70 million in net income for 2007. Management has suggested target growth of around 75-100 restaurants per year (it currently has just more than 640 restaurants open). Even with these guidelines, I'll give Chipotle the benefit of the doubt, and assume that it grows earnings at 50% in 2008, another 50% in 2009, and 25% in 2010. That would shoot net income up to around $200 million by 2010. I'm not making any claims that these growth projections will prove accurate, but in my opinion, they represent a best-case scenario.

I'll stick with the burritos for now ...Under these assumptions, what would Chipotle be worth? With a more sustainable earnings multiple of 25, you get a value around $145 a share ... in 2010. That's only a 5% annualized gain from where Chipotle trades today, leaving zero room for error. A single penny's miss in earnings expectations, or the smallest cut in margins from shifting food prices, could send Chipotle shares running for the exits faster than I can eat a steak burrito with black beans and guacamole.

Think of it this way. LeBron James is an equally outstanding performer on the basketball court. And he no doubt generates a lot of revenue for the owners of the Cleveland Cavaliers. But what if he demanded $1 billion in annual salary, paid in advance? What if he were to get hurt? No matter how talented an athlete (or burrito joint) is, there's always a limit on how much you should be willing to pay.

It's like deja vu all over againWe've seen this before. Yahoo! (NASDAQ:YHOO), Cisco (NASDAQ:CSCO), and Oracle (NASDAQ:ORCL) were all great companies with wonderful growth opportunities in the late 1990s. Everyone knew these companies would post huge earnings gains over the next several years, and they were absolutely right. Was it worth the nosebleed price they had to pay during the go-go tech days? Not even close. Successful investors have a knack for buying the right company at the right price. At its current valuation, Chipotle fulfills the first qualification, but continues to sprint away from the second.

Chipotle has already proved its business model and brand-name strength. Rejecting the bandwagon and waiting for a more sensible price to come along should serve long-term investors quite well.